Be The Quarterback On Your Team
Just as your doctor needs to know about all of your other medical relationships in order to effectively coordinate treatment and make sure each professional on the team is aware of what’s going on, a financial advisor should know your CPA or other tax professional, your attorney and your insurance agent.
This is important because even the “perfect” investment plan can fail for reasons that have nothing to do with investing. Just as an internist will act as the quarterback on your medical team, a good financial advisor will act as the quarterback on your financial team, coordinating all activities.
As one example, many business owners experienced losses in 2008, which provided an opportunity for your advisor to coordinate the conversion from a traditional IRA to a Roth IRA while minimizing the tax consequences.
Develop Alternative ‘Treatment’ Plans
Doctors don’t have crystal balls. They often need to perform a series of tests to make a proper diagnosis and to determine which course of action will likely lead to the desired outcome. Similarly, financial advisors don’t have crystal balls that permit them to forecast stock and bond returns.
In most cases, the only way to determine the asset allocation and spending plan that will provide the best odds of success, while still allowing you to achieve your financial goals without taking too much risk, is to run a Monte Carlo simulation.
Monte Carlo simulations require a set of assumptions regarding time horizon, initial investment, asset allocation, withdrawals, rate of inflation and, very importantly, the distribution of annual returns for different asset classes.
In Monte Carlo simulation programs, the expected final wealth distributions are determined by such factors as the average annual return, the standard deviation of the average annual return, the investment horizon and the withdrawal rate.
The Monte Carlo simulator will randomly select a return for each year and calculate the wealth values over the expected horizon. This process is repeated thousands of times in order to calculate the likelihood of possible outcomes. This allows the advisor to estimate the odds of success of various strategies.